Translation of Decision D-2004-47 from the file R-3492-2002
(Cost of Capital, pages 88 to 102)
3.
COST OF CAPITAL
3.1
COST OF DEBT
For this case, the Régie retained as an estimate of the Distributor’s presumed cost of debt at the
time of decision D-2003-93221, the cost of Hydro-Quebec’s integrated debt as calculated
according to the method presented by the Distributor. The formula for Hydro-Quebec’s
integrated cost of debt according to the regulatory financial framework is as follows:
Cost of the integrated debt
=
Financial expenses
Debt adjusted by the amount of deferred expenses
For the purpose of establishing the integrated cost of debt for the test year, the financial
expenses (the numerator) includes the interest on the long-term debt, the loss on foreign
currency transactions, and guarantee expenses. The debt adjusted by the amount of deferred
expenses (the denominator) corresponds to the long-term debt at the current rate from which
are deducted the financial assets linked to the debt, the deferred loss on foreign currency
transactions, adjustment for retained earnings, and other deferred expenses related to the
debt.222
In this same decision, the Régie indicated to the Distributor that it wanted to examine certain
elements of the calculation of the cost of the integrated debt of Hydro-Quebec in Phase 2 in
order to ensure its proper regulatory treatment. The three elements being studied in Phase 2
are as follows:
1) Inclusion or exclusion of current liabilities as recorded in Hydro-Quebec financial statements;
2) Treatment of the loss on foreign currency transactions transferred to retained earnings
(1,3G$);
3) Calculation of the guarantee expenses.
In addition, during Phase 2, a fourth question was added for analysis. It relates to the
assumptions used for establishing the cost of Hydro-Quebec’s integrated debt and the return on
shareholders’ equity for the year 2004.
221
222
Decision D-2003-93, file R-3492-2002, May 21, 2003, page 57.
Hqd-7, document 2, pages 7 and 9.
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3.1.1
INCLUSION OR EXCLUSION OF CURRENT LIABILITIES AS RECORDED IN
HYDRO–QUÉBEC’S FINANCIAL STATEMENTS
3.1.1.1 POSITIONS OF THE PARTIES
The position of the Distributor is to establish the presumed cost of debt on the basis of HydroQuebec’s integrated long-term cost of debt, which includes a portion of 25% financed at shortterm rates.
In order to follow upon the Régie’s request in decision D-2003-93223 to present a scenario that
includes current liabilities in the calculation of the cost of integrated debt, the Distributor includes
in the numerator the interest on short-term notes, the foreign exchange losses and gains on
short-term elements, and the net investment revenues. In the denominator, the Distributor adds
the short-term notes, its cash balance and short-term investments. If the Régie decided to
include current liabilities in the calculation of the cost of Hydro-Quebec’s integrated debt, the
Distributor thinks that it would be necessary to take into account other components than those
requested by the Régie. The Distributor justifies the additions of the net investment revenues as
well as its cash balance and short-term investments, by indicating that they belong to the
working capital of the corporation.
The Distributor specifies that the regulatory working capital is evaluated using the recovery time
of the Distributor’s expenditures ("lead-lag" study) and does not include a provision to supply the
Distributor with reserve liquidity. The Distributor indicates that its customers are thus not
charged for the financing costs associated with the maintenance of a liquidity reserve in the
form of receivables or of short-term notes. The liquidity reserve is financed partly by short-term
notes, and partly by long-term debt. Given the borrowing rate is in general higher than the
investment return, there is a cost of "bearing" the financing of the reserve which at the present
time is supported by the shareholder.224
Thus, the denominator of the cost of debt with the short-term components would indicate the full
amount of the notes (without deducting the cash balance and the short-term investments), and
the numerator would indicate the full cost of the notes. This assumes that the notes as a whole
constitute a source of financing for the rate base. According to the Distributor, the short-term
notes constitute a source of financing for the rate base only if their value is higher than that of
the cash balance and short-term investments. Moreover, commercial bonds issued by HydroQuebec do not contribute to the financing of long-term assets
223
224
Decision D-2003-93, file R-3492-2002, May 21, 2003, pages 58-59.
Hqd-11 part, document 5, pages 64-68.
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since the in the financial statements commercial bonds have a balance of zero, or nearly zero,
every year.
During the hearing, the Distributor indicates that short term financing at Hydro-Quebec is used
for the specific needs debt servicing and to smooth seasonal variations of revenues (heating
during the winter). Working capital, just like long-term assets, requires permanent financing.
This permanent requirement can be met by long-term financing. In this regard, the Distributor
cites the work of Mr. Paul Halpern, an author recognized in the field of finance, to support its
position.227
The Distributor reiterates that in order to obtain the optimal cost of financing, Hydro-Quebec
uses short-term rates on 25% of its long-term debt. He further indicates that this percentage
was established following a rigorous analysis of risk and return, and until contrary opinion is
presented, this level is adequate. According to the Distributor, the long-term fixed-rate debt
converted to floating rates, costs the rate of bankers’ acceptances plus 5 to 9 basis points and
that, without refinancing risk. By comparison, the cost of financing using commercial paper after
the expenses of supporting credit lines (5 basis points) would be the bankers’ acceptances rate
plus 2 basis points. Therefore, long-term debt at fixed rate converted to floating rates costs
between 3 and 7 basis points more than financing with bonds, but with the advantage of not
having any refinancing risk.229
The Coalition recommends that the Régie takes into account the components of current
liabilities in the calculation of the cost of Hydro-Quebec’s integrated debt. The Coalition
recommends that the Régie excludes the cash balance as well as short term investments, in
addition to increasing the forecast of the sum of the short term notes, before setting the cost of
Hydro-Quebec’s debt.230
The Coalition’s position rests on the matching principle that requires that all firms try to match
the structure and the maturity of their assets to that of their liabilities. The Coalition supports its
position by referring to a study231 which states that 63% of CFO’s (chief financial officers) of
large corporations and particularly at
225
NS, volume 25, pages 23-24.
226
NS, volume 25, page 22.
227
NS, volume 25, page 21.
228
NS, volume 25, page 27.
229
NS, volume 25, pages 30-31.
230
Argument of the Coalition and FCEI/UMQ (Phase 2), pages 43-51.
231
Document No 25 of the Coalition, The Theory and Practice of Corporate Finances: Observations
from the Field, page 224.
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Fortune 500 companies, assert that it is important, or very important, to match the maturity of
liabilities with the useful life of assets.
Moreover, the choice of financing for short-term assets depends on the risk tolerance that the
company is ready to accept. A risk intolerant company would be financed entirely with long-term
financing and would use short-term financing only in emergency cases232. The Coalition
mentions that the cost of long-term debt is generally higher than that of current liabilities
because the periods where the yield curve is reversed are uncommon and generally of short
duration233.
With regard to the exclusion of the cash balance and short-term investments, the Coalition
indicates that the Distributor is already compensated, for its cash balance, by the means of its
return on the rate base.
Lastly, the Coalition indicates that the forecast of the level of short-term notes is significantly
lower compared to the levels234 for 2001, 2002 and 2003.235
3.1.1.2 OPINION OF THE REGIE
It is important to recall that in decision D-2003-93, the Régie decided to use as an estimator of
the Distributor’s cost of debt, the cost of Hydro-Québec’s integrated debt236. The Régie is only
deciding in the current section on the advisability of including, or not including, current liabilities
in the calculation of this estimator.
In terms of the cost of capital, the objective of any firm, regulated or not, is to establish a policy
of financing which makes it possible to obtain an optimal cost of financing. It is however a
complex question, which must take into account the context of the firm and the risks associated
with the various types of financing.
According to the Coalition’s experts, the short-term financing rate is normally lower than the
long-term rate, and it is therefore desirable, according to the matching principle, to resort to
short-term financing insofar as the structure and the maturity of the assets justifies it.
232
233
234
235
236
Proof of D R Lawrence Kryzanowski and of D R Gordon S. Roberts,
pages 12-13.
Arguments of the Coalition and FCEI/UMQ (Phase 2), point 211, page 45.
Hqd-7, document 2, table 2, page 9.
Arguments of the Coalition and FCEI/UMQ (Phase 2), pages 45-46.
Decision D-2003-93, File R-3492-2002, May 21 2003, page 57.
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In the case under study, the evidence is to the effect that Hydro-Quebec resorts to short-term
debt only for specific and temporary needs, and that it resorts to long-term debt for the financing
requirements of the assets recorded in its rate base that it considers as permanent
requirements.
Nevertheless, in order to obtain an optimal financing cost, the Régie notes that the Distributor
finances up to 25 % of its long-term debt at short-term floating rates, which constitutes a
significant portion financed at short-term rates. The Régie also notes that the extra cost enters
as pure short-term debt, and that the portion of long-term debt at floating rate is relatively small,
taking into account the fact that there is no refinancing risk.
The Régie accepts the treatment suggested by the Distributor concerning the integration of
short-term components in the calculation of Hydro-Quebec’s cost of integrated debt.
Consequently, the Régie refuses the Coalition’s proposal to include the elements of current
liability as recorded in the financial statements in the calculation of the Hydro-Quebec’s cost of
integrated debt.
3.1.2
TREATMENT OF THE FOREIGN EXCHANGE LOSS TRANSFERRED TO
RETAINED EARNINGS (1,3 G $)
3.1.2.1 Position of the Parties
At the request of the Régie in decision D-2003-93237, the Distributor presented a list of detailed
annual amounts that are to be removed from the balance of the foreign exchange loss
transferred to retained earnings. The Distributor has produced supplemental informational238 in
response to an information request formulated in the document Régie-2 on the treatment of the
foreign exchange loss transferred to retained earnings.
According to the Distributor, the basic concept of regulatory cost is to establish what it costs to
service the debt in dollars obtained from the debt to finance the assets of the rate base. Thus it
is necessary to deduct, from the book value of the debt, the amounts that do not constitute
entries of funds likely to finance the assets. The transfer of the foreign exchange loss to retained
earnings did not result in a likely source of funds capable
237
238
D-2003-93 decision, R-3492-2002 file, May 21, 2003, page 58.
Hqd-13 part, document 6.30, pages 1-12.
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of financing the assets239. Before applying the new standard 1650,240 one could easily identify
the amounts included in the value of the debt at the current rate that had not been the object of
fund entries. This amount corresponded fully to the net foreign exchange loss or the unrealized
foreign exchange loss (i.e. the gross foreign exchange loss – the amortization that had been the
object of fund entries).
According to the former standard, the unrealized foreign exchange loss on the debts and swaps
not used to cover future re-entries in US dollars were amortized over the remaining maturity of
these debt securities, whereas the foreign exchange loss on debts and swaps covering future
re-entries was deferred until their maturity, which corresponds to the date of realization of these
future re-entries.
Effective January 1, 2002, according to the new standard, any unrealized foreign exchange
profit or loss resulting from the conversion of monetary elements made out into foreign
currencies is immediately reported, except if the monetary element covers future re-entries in
US dollars. Thus, for the purposes of the application of the old and new accounting standards
related to the conversion of foreign currencies, it is important to distinguish the elements of debt
according to three following categories':
1)
2)
3)
Foreign debts converted in Canadian dollars via the use of a
swap before December 31, 2001;
Foreign debts for which no hedging had been used from an accounting perspective
(uncovered debts);
Foreign debts and swaps in US $ considered as hedges for future re-entries in
US $ (debts covering future re-entries in US$).
Debts previously converted by swap
According to the Distributor, the use of a currency swap to cover a foreign debt allows to
eliminate or freeze the foreign exchange profit or loss related to this debt. Before the new
standard was put in place, the foreign exchange loss frozen by the combination of debt and
swap would be amortized over the remaining life of the security. This amortization charge would
have been constant, therefore insensitive to the exchange rate, and would have been included
in the foreign exchange loss included in the numerator. With the application of the new
standard, this net loss (frozen loss) is transferred to retained earnings as of December 31, 2001.
239
240
Hqd-7, document 2, page 20.
Handbook of the ICCA (Canadian Institute of Chartered Accountants).
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Effective January 1, 2002, profits and losses from foreign exchange transactions resulting from
the conversion into Canadian dollars of this combination of debt and swap is from now on
immediately reported in the corporations’ results. But these profits or losses cancel each other
because of this hedge. Therefore, starting January 1st 2002, debts previously transformed by
swap, do not contribute any more to the foreign exchange loss included in the numerator of the
calculation of the cost of debt, which results in an economy for the Distributor’s customers.
The adjustment to retained earnings is constant until the expiry of the debt. The reported foreign
exchange loss becomes null following the application of the new accounting standard.
Uncovered debts
The Distributor explains that according to the old rules, these debts contributed to the foreign
exchange loss via an amortization charge varying with time according to the exchange rate.
Effective January 1, 2002, this cost disappears.
With the application of the new standard, the unrealized foreign exchange profit or loss resulting
from the conversion of the uncovered debts should have been reported immediately in the
statements as of January 1, 2002. However, an easing in the application of the cover by sales
has allowed that for these debts the loss or gain be recorded at maturity.
Given that at December 31, 2001, the portion of the debt issued in foreign currency was
considered uncovered, the net loss on the uncovered portion was transferred to retained
earnings. Just like the first category, the portion transferred to retained earnings will not
contribute any more to the foreign exchange loss included in the numerator for the calculation of
the cost of debt, which translates, once again, into an economy for the Distributor’s customers.
Only the profits and losses resulting from exchange rate fluctuations subsequent to
December 31, 2001 will be considered in the numerator of the cost of debt and only at their
maturity.
The adjustment to retained earnings is constant until the maturity of the debt. The deferred
foreign exchange loss fluctuates according to the annual variation of the exchange rate.
Debts covering future re-entries in US $
The Distributor explains that foreign exchange profits or losses resulting from the conversion of
a monetary element in US$ used as a cover for future re-entries into US$ is deferred to
maturity. The debts and swaps included in this category were not the object
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of an adjustment to retained earnings, because the treatment is exactly the same according to
the old or the new standard. Just like the preceding category, exchange rate fluctuations will be
considered in the numerator of the cost of debt only at the year of maturity. For the
denominator, the annual variation of the deferred foreign exchange loss will be the same as the
annual variation of the debt at the current rate.
Contribution of the Annex 1 debt to the components of the integrated cost
of debt in 2003 and 2004
The debts presented in Annex 1 of Hqd-7, document 2 correspond to those that were the
subject of a transfer to retained earnings as of December 31, 2001. These are, in their large
majority, debts previously converted by swap as of December 31, 2001, and to a lesser extent,
debts in US currency that were not considered to have a hedging purpose on this date, but
thereafter were used for such a purpose.
According to the Distributor, the debts of annex 1 are not found in the numerator in foreign
exchange losses. Debts transformed beforehand by swap at December 31, 2001 are no longer
contributing to foreign exchange losses. Moreover, debts not considered as having a hedging
purpose do not affect the numerator, since none of them are arriving at maturity in 2003 and
2004 and that foreign exchange losses after December 31, 2001, are deferred until maturity.
The Distributor explains that the foreign exchange profits between 2002 and 2003 are entirely
attributed to other kinds of debts than those of Annex 1, that is to say debts in American
currency with a hedging purpose before December 31, 2001 and arriving at maturity thereafter.
As for the numerator, all the securities not included in Annex 1 are included in the denominator.
However, the debts previously converted by swap will not affect the evolution of the foreign
exchange loss included in the debt at the current exchange rate as well as the deferred foreign
exchange loss, since the profits and losses resulting from the combination of debt and swap are
cancelled because of the hedge. Only when they arrive at maturity will the fixed contribution of
these debts in the denominator be removed.
However, between 2003 and 2004, the debts converted by swap arriving at maturity appearing
in Annex 1 will contribute to the reduction of the debt at the current rate. These same maturities
result in a reduction of $42 M to the adjustment to retained earnings. Given the transfer to
retained
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earnings, these debts and swaps were no longer contributing to the net foreign exchange loss.
According to the Distributor, the foreign exchange profits and losses resulting from exchange
rate fluctuations subsequent to December 31, 2001, applied to the debts covering future reentries in US$, has an influence on the evolution of the unrealized foreign exchange losses
included in the debt at the current rate and on the evolution of the deferred foreign exchange
losses.
For the debts covering future re-entries that were the subject of an adjustment to retained
earnings, this adjustment will remain constant until the expiry of these debts. The Distributor
indicates that none will come to maturity in 2003 and 2004.
The evidence of the Coalition that was not specifically treating the foreign exchange loss
transferred to retained earnings ($1,3G) was not retained in the present phase of the case given
that the evidence was considered inadmissible by Decision D-2003-201. In this decision, the
Régie indicated that the opinions with respect to the stand-alone concept and those questioning
the inclusion of the foreign exchange losses in the cost of the integrated debt of Hydro-Quebec,
which is used as estimator for the cost of debt of the Distributor, cannot to be heard in Phase 2,
the Régie having ruled in this respect during Phase 1 241.
3.1.2.2 OPINION OF THE REGIE
In decision D-2003-93, the Régie required the Distributor to clarify the regulatory treatment of
the foreign exchange loss of $1,3 G transferred to retained earnings. The Régie considers that
the evidence242 in the case made it possible to specify that the proposed regulatory treatment is
adequate. The Régie accepts the treatment proposed by the Distributor to establish the annual
amounts to be deducted from the balance of the foreign exchange loss transferred to retained
earnings.
For the next rate cases, the Régie requires that the Distributor provides from the list of the debts
of Annex 1, Hqd-7, document 2, the impact in dollars of these debts on the foreign exchange
loss in the numerator as well as on the net deferred foreign exchange loss and the adjustment
of retained earnings in the denominator.
241
242
D-2003-201 decision, R-3492-2002 file, October 30, 2003, page 8.
Hqd-13 part, document 6.30, pages 1-12.
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3.1.3
3.1.3.1
CALCULATION OF THE GUARANTEE EXPENSES
POSITION OF THE PARTIES
The position of the Distributor is that the guarantee expenses really incurred must be
recovered. The calculation cannot simply be carried out on the amount of the debt that was
subject to fund entries, because the expenses really incurred would not be recovered. It is to be
noted that the value of the debt presented in the denominator of the cost of debt includes only
elements that were subject to entries of funds.
The evidence of the Coalition with regard to the guarantee expenses was not retained in the
present phase of the case as it was considered inadmissible by decision D-2003-201. In this
decision, the Régie states that the chapter V (Charge for credit enhancement) 243 of the
evidence of the experts Kryzanowski and Roberts, as presented in the expertise, does not treat
this subject according to the framework fixed in Phase 2 and questions elements that were the
object of a clear decision in Phase 1.
3.1.3.2
Opinion of the Régie
In decision D-2003-93, the Régie accepted the principle of recognizing the inclusion of the
guarantee expenses in the calculation of the cost of the integrated debt of Hydro-Quebec.
The Régie is satisfied with the evidence according to which the calculation cannot only be
carried on the amount of the debt that is subject to entries of funds since on the basis of the
selected methodology, the expenses really incurred would not be completely recovered. These
expenses represent 50 basis points of the securities guaranteed by the government, in
circulation at December 31 of the previous year, converted into Canadian dollars at the value of
the exchange rate in force at the closure 244.
The Régie accepts the methodology suggested by the Distributor in this case with regard to the
calculation of the guarantee expenses in the calculation of the cost of integrated debt of HydroQuebec.
243
244
Proof of DR Lawrence Kryzanowski and DR Gordon S. Roberts, pages 43-50.
Phase 1, Hqd-7, document 1, page 31.
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3.1.4
ASSUMPTIONS USED TO ESTABLISH THE COST OF INTEGRATED DEBT OF
HYDRO-QUÉBEC AND THE RETURN ON EQUITY FOR THE YEAR 2004
3.1.4.1 POSITION OF THE PARTIES
The Distributor presented its assumptions on exchange rates and interest rates in the original
filing submitted on August 14, 2003. Following information requests, the information sources for
each of the data used has been provided.
The Distributor explains the calculation of the average presented in the evidence245 for the years
2003 and 2004. Initially, the real data are extracted. They originate from the data sources
referred to each month when the data is available at the moment of the preparation of the
projections. For this case, the real data ends, according to the case, in April 2003 or May 2003.
The data for the projected months are taken from the projections of the Consensus Forecast246
for 3 months and 12 months. To realize this, the Distributor interpolates linearly the rates of the
months between the end of the historical data and the rate for 3 months from the Consensus
Forecast, and in a similar way for the rates forecasted in 3 and 12 months. The rates of the
Consensus Forecast for the last month are kept constant until the end of the year 2004.
For the rates which are not shown in the tables of the Consensus Forecast, the actual
differential between the last five years’ average of the desired rate and the most similar rate
available in the Consensus Forecast is calculated. This differential is added to the monthly rates
projected from the Consensus Forecast for the similar rate, as previously interpolated and
extrapolated. The annual averages are the average of the monthly rates calculated and/or
observed.
As for the forecast of the borrowing program for 2003, it was of 1940 M $. The part carried out
as of May 31, 2003 is 1 490 M $; the part not carried out therefore amounts to 450 M $. The
amount forecasted in the borrowing program for 2004 is 2 055 M $247.
The initial position of Distributor is that the cost of debt must be calculated on the basis of the
same financial parameters as those used in the file, that is the Consensus Forecast of
May 2003.
245
246
247
Hqd-7, document 2, appendix 2.
Hqd-7, document 2, appendix 2, Consensus Forecast of May 12, 2003.
Hqd-11, document 1, pages 59-65.
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In response to a question of the Régie, during the hearing, about the opportunity of updating its
assumptions, the Distributor indicated that it was necessary to have an objective rule and that
its application be symmetric 248. At the request of the Régie, the Distributor presented the results
of an update to the cost of the integrated debt of Hydro-Quebec from the Consensus Forecast
of August 11, 2003249.
For future cases, the position of the Distributor250 is as follows:
•
The cost of the debt will be calculated on the basis of the same financial parameters as
those used in the forecast of the sales in August of each year;
•
The rate of return will be adjusted at the date of the Régie’s decision.
3.1.4.2
Opinion of the Régie
The Régie notes that the assumptions used in the initial evidence for the establishment of the
cost of the integrated debt of Hydro-Quebec 2004 come mainly from the Consensus Forecast of
May 12, 2003.
In the case of Hydro-Quebec, the relative importance of the re-financings and of the new annual
financial requirements and their significant impact on the cost of debt, as well as the significant
impact that might result from exchange rate and interest rate fluctuations, justifies giving a
special attention to the choice of the date chosen for the reference data used to establish the
required revenues. It is from this perspective that the Régie asked that an update of the
projections with more recent data from Consensus Forecast be presented.
The Régie considers that the concern of the Distributor to maintain a constant approach from
one case to another is legitimate and deserves to be thoroughly examined. In the absence of a
substantive debate on the optimal approach for setting the economic and financial assumptions
on a longer-term basis, the Régie decides to wait until a more detailed examination is made in a
later rate case before making a decision on such an approach.
248
249
250
NS, volume 25, page 234.
Hqd-13, document 6.31.
Plan of final argumentation of Phase 2 of the Distributor, page 21.
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The Régie notes that the Distributor has not objected to the principle of using more recent
data251.
For the establishment of the cost of debt for 2004, the Régie decides to use the updated
financial assumptions made by the Distributor on the basis of the data from the Consensus
Forecast of August 11, 2003. According to this update, the cost of debt for the year 2004
is 7,41%252. According to the Régie, this is a suitable approach in the context of a first rate case
for the Distributor. This approach allows a reasonable estimate of the financing costs which will
be incurred in 2004 by Hydro-Quebec and which will have to be supported by the customers in
the applicable tariffs.
Taking into account this update, the Régie estimates, on the basis of the data submitted in the
evidence, that the cost of debt of the Distributor for the year 2004 should be reduced by
approximately 25 M $ compared to the amount indicated in its request.
3.2
3.2.1
RATE OF RETURN ON THE RATE BASE
POSITION OF THE PARTIES
The Distributor affirms that the beta and the risk premium were maintained fixed during the
whole horizon of analysis, because the Régie in its decision D-2003-93 did not consider as
appropriate the presentation in phase 2 of new detailed evidence on the rate of return on
equity253.
The Distributor presents a risk-free rate of 5,307 % based on the data from the Consensus
Forecast of July 14, 2003, that is one month before the submission of the case to the Régie, in
accordance with the instructions of the Régie formulated in Decision D-2003-93. For a lack of a
specific method, the calculation of the risk-free rate for the year 2003 was made on the same
basis as that for the year 2004. The Distributor specifies that the rate thus obtained for this year
is compatible with the rates observed in 2003254.
The Distributor requests from the Régie a rate of return on equity for the projected year 2004 of
8,712 % 255. However, it asked that this rate be adjusted with the
251
252
253
254
255
NS, volume 25, page 234.
Hqd-13 part, document 6.31, page 3.
Hqd-7 part, document 3, page 4.
Hqd-7 part, document 3, page 5.
Hqd-7 part, document 3, page 4.
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data from the Consensus Forecast at the closest date to the decision of the Régie, if she
decides to follow such an approach for the cost of debt.
On the basis of a cost of debt of 7,865 % and a rate of return on equity of 8,712 %, the
Distributor asks the Régie to approve the rate of 8,161 % as the rate of return on equity as the
basis for setting the rates for the projected year 2004 256.
3.2.2
OPINION OF THE RÉGIE
In its decision D-2003-93, the Régie required the Distributor to present in Phase 2 an update of
the risk-free rate as well as evidence related to a mechanism for adjusting the rate of return257.
However, it did not consider appropriate that new evidence be presented concerning the issues
of methodology or others that were the subject of a debate and decision in Phase 1.
In decision D-2003-138 of July 7, 2003, the Régie accepts the request of the Distributor to defer
the study of the formula of annual adjustment of the rate of return requested in decision D-200393. Consequently, the examination within the framework of this case is limited to the update of
the risk-free rate.
The initial evidence of the Distributor presents an update of the risk-free rate based on the most
recent data available in the Consensus Forecast at the time when the case is filed, i.e. that of
July 14, 2003.
As these data can fluctuate to a significant degree from month to month, the choice of a
reference date can influence required revenues upward or downward.
As indicated in the section on the cost of debt, the Régie considers suitable in this case to take
into account the most recent available data to establish the cost of capital and the required
revenues for year 2004. The Régie notes that the Distributor adheres to this approach insofar as
it will also be applied in subsequent cases. The merits of this question could be examined in the
next cases.
256
257
Hqd-7, document 1, page 3.
Decision D-2003-93, R-3492-2002, May 21, 2003, page 75.
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Translation of Decision D-2004-47 from the file R-3492-2002
(Cost of Capital, pages 88 to 102)
Consequently, the Régie requires the Distributor to use the most recent data in order to
establish the forecast of the rate of return on equity for the year 2004. To do this, the Distributor
will have to use the data from the Consensus Forecast of January 12, 2004 and to apply the
methodology presented in Decision D-2003-93. The Régie orders the Distributor to update
Tables 1 and 2, Hqd-7, document 3 and to present these tables to the Régie no later than
March 8, 2004 at 12:00.
Taking this update into account, the Régie estimates, on the basis of published data, that the
Distributor’s return on equity for the year 2004 will have to be increased by approximately 10 M$
compared to the amount indicated in its request.
In addition, the Régie requires that the Distributor updates in a document submitted no later
than March 8, 2004 at 12:00, the rate of return on the rate base for the year 2004, taking into
account the above decisions concerning the costs of debt and equity.
3.3
3.3.1
PROSPECTIVE COST OF CAPITAL
POSITION OF THE PARTIES
The Distributor reports that in its decision D-2003-93, the Régie accepts the methodology for
determining the prospective cost of capital proposed in Phase 1 of the present case258.
The Distributor requests the Régie’s approval of an average rate of the prospective cost of
capital of 7,061 % for the evaluation of its investment projects during the projected year 2004259.
This rate is obtained from a capital structure of 65 % debt and 35 % equity with respective rates
of 6,18 % and 8,71 %.
3.3.2
OPINION OF THE REGIE
With regard to the prospective cost of capital, the Régie requires the Distributor to update this
rate for 2004, on the basis of the data from the Consensus Forecast of August 11, 2003 for the
projected cost of debt, while taking into account the new updated rate of return on equity, and to
file this update no later than March 8, 2004 at 12:00.
258
259
Hqd-7, document 4, page 3.
Hqd-7, document 4, page 3.
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